Margaret Doyle

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$1,000 gold could soon lose its shine

September 8, 2009

The price of gold has broken through $1,000 an ounce for the first time since February’s brief intraday peak. The yellow metal is traditionally seen as a counterweight to dollar weakness and a safe haven in troubled times. Clearly not every investor believes the bullish narrative underlying the past six months’equity-market rally.

There have been a couple of triggers for gold’s current strength. After rallying strongly from December through early March, as equity markets went into meltdown, the dollar has fallen back sharply.

Moreover, the persistent questions about its role as a reserve currency were given a fillip by a report published by the United Nations Conference on Trade and Development (UNCTAD) on Sept. 7 that called for a new currency, to be issued by a new global reserve bank backed by UN members.

Gold bugs like to point to its qualities as a hedge against inflation. After all, supply is limited by nature: the U.S. Federal Reserve is printing $70 billion in bonds this week, compared to around $100 billion-worth of annual gold supply.

Others have noted that, as the Fed’s printing presses roll, the price of assets denominated in the greenback should also rise. The Chinese have been buying up gold over the past three years, yet the metal still accounts for just 1.6 percent of its reserves. Beijing has even encouraged consumers to invest.

Of course, gold’s recent strength is not all that it appears. During the stagflation of 1980, gold peaked at $850, the equivalent of more than $2,000 today once adjusted for inflation. Moreover, there are also puzzling aspects to gold’s rise. It seems at odds with the “green shoots” of recovery in the real economy and the phenomenal equity rally on the back of those signs. Most fundamental gold rallies are also accompanied by underlying industrial and jewellery demand, but both of these have been falling sharply.

It may well be that technical factors are at play here. On both recent occasions (February this year and March 2008) when gold breached $1,000 an ounce, short-covering was at its root. Some analysts also reckon that the pessimism about the appetite for government bonds is overstated. They point to Japan’s experience, where yields remain rock-bottom despi

Albert Edwards, strategist with Societe Generale, warns that the world economy is heading for deflation, rather than the inflation that mammoth government bond issuance might suggest. He adds that all of these government bonds will be hoovered up by commercial banks, who will want to redress the balance between risky assets like real estate loans and government bonds. New rules on capital and liquidity will also force them to do so. Unlike gold, the bonds pay a coupon, however slender.
All this points to a very shaky underpinning to gold’s new perch. Would-be Goldfingers might soon find they are suffering from burnt digits.

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  • About Margaret

    "Margaret Doyle is a Reuters Breakingviews columnist, based in London. She writes about investment banking. She has been a journalist for over 14 years. She has written for The Daily Telegraph and The Economist and presented various radio programmes for the BBC. She began her career as a consultant at McKinsey & Co. She has an economics degree from Trinity College, Dublin and an MBA from Harvard Business School, which she attended as a Fulbright scholar. She is a Conservative Member of Westminster City Council."
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